12712_long run costs

8/6/2019 12712_long Run Costs

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slide 1Long-run costs

LONG-RUN COSTSLONG-RUN COSTS

In the long-run there are no fixed inputs, andtherefore no fixed costs. All costs are variable.

Another way to look at the long-run is that in thelong-run a firm can choose any amount of fixed

costs it wants for making short-run decisions.


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The Long-run Average Cost Curve

The long-run average cost curve shows theminimum average cost at each output levelwhen all inputs are variable, that is, when thefirm can have any plant size it wants.

There is a relationship between the LRAC curveand the firm's set of short-run average costcurves.


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SR and LR Average Costs

Economists use the term plant size to talkabout having a particular amount of fixedinputs. Choosing a different amount of plant

and equipment (plant size) amounts tochoosing an amount of fixed costs.

Economists want you to think of fixed costs asbeing associated with plant and equipment.Bigger plants have larger fixed costs.


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If each plant size is associated with a differentamount of fixed costs, then each plant size fora firm will give us a different set of short-run

cost curves.

Choosing a different plant size (a long-run

decision) then means moving from one short-run cost curve to another.


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Economists usually assume that plant size is infinitelydivisible (variable). In the case of finely divisible plantsize, the LRAC curve might look like this:

LRAC

Each small U-shaped

curve is a SAC curve.

Each small U-shaped

curve is a SAC curve.

The LRAC

curve.

$/Q

QAverage costs for a

typical firm.


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In the preceding graph, each short-run cost curvecorresponds to a particular amount of fixedinputs.

As the fixed input amount increases in the longrun, you move to different SR cost curves,

each one corresponding to a particular plantsize.


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For example, advantages implicit in large scaleproduction (with large plants) may allow firmsto produce large outputs at lower cost per unit.

On the other hand, firms may get so big that everincreasing managerial and monitoring costs

may cause unit costs to rise.


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LRAC

$/Q


typical pizza firm.

LRAC shows

economies of

scale here.

ECONOMIES OF SCALE: When outputincreases, long-run average costs decline.


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LRAC

$/Q


typical pizza firm.

LRAC shows

diseconomies of

scale here.

DISECONOMIES OF SCALE: When outputincreases, long-run average costs increase.


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Why Costs Curves are U Shaped???

Why does Cost Curves fall in the beginning????

Cheaper Materials and Capital Equipment Technological External Economies

Development of Skilled Labour and Division of Labour

The Growth of Supportive Industries

Improved Transportation and Marketing FacilitiesWhy does Cost Curves rise later????

Difficulties of Management

Entrepreneur is fixed and indivisible

Rise in prices of some factors Eg.-Raw Materials and Capital Goods(Short Supply and Scarce), Wages of Skilled Labour

(Training and Specialised Skill)


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MODERN COST THEORY: L SHAPED COST CURVE

Y

X

LRAC

LongRunAvera

ge

Cost

Output


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L Shaped Cost Curve implies that in the beginning when output isexpanded, cost per unit falls rapidly due to economies of scale. Evenafter that cost does not rise; it may either remain constant or it mayeven go on falling slightly.

Reasons:

Technical or production Economies- New Techniques of Production

Decentralisation and Improved Skills and Productivity of Labour.

Lower Repair Costs

Production of required Materials and Equipment at lower cost instead of buying fromothers.

Development of Appropriate Managerial Techniques- Appropriate Organisational and Managerial Set-up

Appropriate Managerial Techniques

Offset of increasing managerial costs by production economies

12712_long run costs

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